Could independent central banks be advisory?

With fiscal councils (or Independent Fiscal Institutions) now commonplace in advanced economies, a natural question arises. Why are all these councils advisory, while independent central banks have control over monetary policy? For fiscal policy we seem to have delegated advice [1], while for monetary policy we have delegated control. In this post I want to focus on control over how policy instruments are changed, and not control of the goals of policy. For clarity assume that governments still control the ultimate goals of monetary policy (e.g. an inflation target) and fiscal policy (e.g. a target for the deficit in 5 years time).

As fiscal councils are the less familiar, it is natural to try and answer this question by asking why fiscal councils are not given control over fiscal policy. I am, of course, not talking about controlling the detail of government spending or taxes, but instead setting a target for the projected deficit which governments should aim to achieve in a budget. There are lots of potential answers to that question, which I have written about elsewhere.

However we could ask the question the other way around, and I cannot remember anyone asking it this way. Why are there no independent advisory central banks? In the UK, for example, imagine having the MPC meeting, and then immediately advising (in secret for a short time) the Chancellor of their recommendation for interest rates. The Chancellor would very quickly (within an hour or day?) decide whether to accept that recommendation or do something different. After that, the decision and the MPC’s recommendation would be announced.

Two straightforward points. First, a system of that kind could only work in the US if Congress gave the President the power to accept the Fed’s recommendation or impose the President’s own decision: perhaps not something we would want to contemplate right now. In the Eurozone the ECB would have to give recommendations to Ecofin, which might make it both impractical and perhaps undesirable. Second, this form of delegation is obviously weaker than giving complete control to the central bank, and that in itself may be a reason why it is not adopted.

Nevertheless, for a country like the UK, it would be a mistake to underestimate the political pressure the Chancellor would be under to accept the central bank’s public advice. The Chancellor or Treasury minister would be entirely responsible from deviating from the recommendation given to them, and if it went wrong they would incur a considerable political cost. In these circumstances, it would be understandable for governments to reason that there was little to be gained from having the power to overrule central bank advice. They would get it in the neck if they overruled this advice and turned out to be wrong, but equally if the MPC make mistakes they would also have ultimate responsibility for accepting this advice. If in practice nearly all of the time they are going to accept the central bank’s recommendations, why not give them complete control so that at least you are not implicated when things go wrong.

If this reasoning is correct, it raises a difficult question for those who argue against central bank independence but still accept monetary policy’s primary role in stabilising the economy outwith the ZLB. Of course many governments used to be happy to control monetary policy, as long as the advice they were getting was secret. But if that advice is public, as surely we all agree it should be, would even formally advisory central banks start to in effect control monetary policy because governments would never incur the risk of going against their advice? In which case, why so much fuss about independent central banks that do control monetary policy being undemocratic? I stress again that I’m talking about control of month to month interest rate changes, and not the goals of monetary policy (inflation targets or NGDP targets). I think those should be democratically decided (as in the UK, but not the US or EZ), and that central banks should be accountable in a meaningful way if they do not achieve these goals. But for the day to day business of setting rates, I cannot see that much would be gained by putting those under democratic control. 

[1] In the absence of delegating advice to an independent institution, advice would come from the the internal civil service. 

Helicopter money and fiscal policy

Both John Kay and Joerg Bibow think additional government spending on public investment is a good idea, and that helicopter money (HM) is either a distraction (Bibow) or fiscal policy by subterfuge (Kay). They are right about public investment, but wrong about HM.

We can have endless debates about whether HM is more monetary or fiscal. While attempts to distinguish between the two can sometime clarify important points (as here from Eric Lonergan) it is ultimately pointless. HM is what it is. Arguments that attempt to use definitions to then conclude that central banks should not do HM because its fiscal are equally pointless. Any HM distribution mechanism needs to be set up in agreement with governments, and existing monetary policy has fiscal consequences which governments have no control over.

Here is where Kay and Bibow are right. At this moment in time, even if a global recession is not about to happen, public investment should increase in the US, UK and Eurozone. There is absolutely no reason why that cannot be financed by issuing government debt. Furthermore, in the event of a new recession, increasing ‘shovel ready’ public investment is an excellent countercyclical tool. Indeed there would be a good case for bringing forward public investment even if monetary policy was capable of dealing with the recession on its own, because you would be investing when labour is cheap and interest rates are low.

Where Bibow is wrong is that the existence of HM in the central bank’s armory in no way compromises the points above. HM does not stop the government doing what it wants with fiscal policy. Monetary policy adapts to whatever fiscal policy plans the government has, and it can do this because it can move faster than governments.

This goes part of the way to answering Kay, but he also suggests that HM is somehow a way of getting politicians to do fiscal stimulus by calling it something else. This seems to ignore why fiscal stimulus ended. In 2010 both Osborne and Merkel argued we had to reduce government borrowing immediately because the markets demanded it.

HM is fiscal stimulus without any immediate increase in government borrowing. It therefore avoids the constraint that Osborne and Merkel said prevented further fiscal stimulus. To put it another way, they did not say that increasing government spending or cutting taxes were bad in itself, but just that they were extremely unwise because they had to be financed by adding to government debt. HM is not financed by increasing government debt.

Many argue that these concerns about debt are manufactured, and that in reality politicians on the right pushing austerity are using these concerns as a means of achieving a smaller state: what I call here deficit deceit. HM, particularly in its democratic form, calls their bluff. If we can avoid making the recession worse by maintaining public spending, financed in part by creating money while the recession persists, how can they object to that? Politicians who wanted to use deficit deceit will not like it, but that is their problem, not ours.

There is a related point in favour of HM that both Kay and Bibow miss. Independent central banks are a means of delegating macroeconomic stabilisation. Yet that delegation is crucially incomplete, because of the lower bound for nominal interest rates. While economists have generally understood that governments can in this situation come to the rescue, politicians either didn’t get the memo, or have proved that they are indeed not to be trusted with the task. HM is a much better instrument than Quantitative Easing, so why deny central banks the instrument they require to do the job they have been asked to do.

The 'strong case' critically examined

Perhaps it was too unconventional setting out an argument (against independent central banks, ICBs) that I did not agree with, even though I made it abundantly clear that was what I was doing. It was too much for one blogger, who reacted by deciding that I did agree with the argument, and sent a series of tweets that are best forgotten. But my reason for doing it was also clear enough from the final paragraph. The problem it addresses is real enough, and the problem appears to be linked to the creation of ICBs.

The deficit obsession that governments have shown since 2010 has helped produce a recovery that has been far too slow, even in the US. It would be nice if we could treat that obsession as some kind of aberration, never to be repeated, but unfortunately that looks way too optimistic. The Zero Lower Bound (ZLB) raises an acute problem for what I call the consensus assignment (leaving macroeconomic stabilisation to an independent, inflation targeting central bank), but add in austerity and you get major macroeconomic costs. ICBs appear to rule out the one policy (money financed fiscal expansion) that could combat both the ZLB and deficit obsession. I wanted to put that point as strongly as I could. Miles Kimball does something similar here, although without the fiscal policy perspective

Of course many macroeconomists do see the problem, but the solutions they propose are often just workarounds. Things like Quantitative Easing, or NGDP targets, or a higher inflation target. [1] None completely remove the basic difficulty created by the ZLB. (One proposal that does is negative interest rates coupled with eliminating paper money, which I will come back to.) As a result, these workarounds mean that in response to a sharp enough recession, we would still regret no longer having the possibility of undertaking a money financed fiscal stimulus.

I also think there is a grain of truth in the argument that ICBs created an environment where deficit obsession became easier. Take the UK for example. In the 2000s the organisation that came to dominate budget analysis was the IFS. They are excellent on both the microeconomics of particular budget measures and their costing. Before the Great Recession that meant that all the IFS needed was a macro forecast (of which there are many) and they had all they required to provide excellent budget analysis. The IFS did not have strong macro policy expertise, and sometimes this shows, but as long as the consensus assignment worked that did not matter.

One of the those working at the IFS during this Labour government period was Rupert Harrison. In 2006 he became chief of staff to George Osborne. He helped introduce, perhaps reflecting his IFS experience, two important and positive policy innovations: setting up the OBR (with some minor assistance from a certain UK academic), and a form of fiscal rule (a five year deficit target) which allowed debt to be a shock absorber. But he also appeared to bring the received wisdom on the consensus assignment untroubled by the ZLB, which meant that Osborne could give a speech in 2009 outlining the macroeconomic basis of his strategy in which the ZLB was not mentioned.

This is an example of a more general point, which Robert in comments reminded me I could have made to strengthen the strong argument still further. With ICBs, macroeconomic expertise can move from finance ministries to central banks, leaving finance ministries unprepared for what they may need to do in a major recession.

But this grain of truth runs up against a real difficulty, which is the major flaw in the ‘strong argument’ I set out in the earlier post. To see the flaw ask the following question: in the absence of ICBs, would our deficit obsessed governments actually have undertaken a money financed fiscal stimulus? To answer that you have to ask why they are deficit obsessed. If it is out of ignorance (my Swabian syndrome), then another piece of macro nonsense that ranks alongside deficit obsession is the evil of printing money in any circumstances. I suspect a patient suffering Swabian syndrome would also be subject to this fallacy. If the reason is strategic (the desire for a smaller state) the answer is obviously no. We would simply be told it could not be done because it would open the inflation floodgates.

Following my grain of truth idea you might counter that without ICBs the knowledge within or outside government that these excuses were without foundation would be greater, and so governments could not get away with them so easily. But you would still have plenty of economists from the financial sector telling you that not only did you need to reduce debt rapidly to appease the markets, but also that any government printing money would scare the markets even more. Indeed, would governments alone have had the courage to undertake the scale of QE that we have seen ICBs undertake?

As for the argument that macroeconomic expertise gets concentrated in central banks, surely the answer here is to allow that expertise into the public domain by making central banks more open, and to directly combat the forces that make some central bank leaders routinely argue for austerity when they can no longer effectively combat deflation.

The basic flaw with my strong argument against ICBs is that the ultimate problem (in terms of not ending recessions quickly) lies with governments. There would be no problem if governments could only wait until the recession was over (and interest rates were safely above the ZLB) before tackling their deficit, but the recession was not over in 2010. Given this failure by governments, it seems odd to then suggest that the solution to this problem is to give governments back some of the power they have lost. Or to put the same point another way, imagine the Republican Congress in charge of US monetary policy.

But if abolishing ICBs is not the answer to the very real problem I set out, does that mean we have to be satisfied with the workarounds? One possibility that a few economists like Miles Kimball have argued for is to effectively abolish paper money as we know it, so central banks can set negative interest rates. Another possibility is that the government (in its saner moments) gives ICBs the power to undertake helicopter money. Both are complete solutions to the ZLB problem rather than workarounds. Both can be accused of endangering the value of money. But note also that both proposals gain strength from the existence of ICBs: governments are highly unlikely to ever have the courage to set negative rates, and ICBs stop the flight times of helicopters being linked to elections.

      

These are big (important and complex) issues. There should be no taboos that mean certain issues cannot be raised in polite company. I still think blog posts are the best medium we have to discuss these issues, hopefully free from distractions like partisan politics.  

   

[1] Please do not misunderstand what I mean by workarounds. The workaround may be still be useful in its own right (I have argued that monetary policy should be guided by the level of NGDP), but it does not completely remove the problem of the ZLB.

 

Faux meritocracy

When Canadian Prime Minister Justin Trudeau was asked why his new cabinet had as many women as men, he replied “because it’s 2015”. But as Owen Jones notes, when it comes to the UK and educational background, many people still presume that our leaders should come from the elite universities.

In an ideal world these would be different issues. In a truly meritocratic society those going to elite universities would be doing so on the basis of their abilities rather than who their parents were. In the UK and I suspect elsewhere we are some way from that ideal. Although I am pretty sure the reasons for this largely occur before 18, I also agree that Oxbridge could improve matters greatly if they stopped selecting students on the basis of interviews. It is one of many reasons why Oxbridge interviews reduce social welfare.

Here is a more minor observation which I think is quite revealing. As Owen says a big part of the problem with Oxbridge is that those from many backgrounds are put off from applying because they think it is only for toffs. It isn’t, but sometimes Oxbridge seems to pretend otherwise. For example there is the ludicrous Oxford tradition of making every student dress up in gowns and worse when they take exams. It means that just at the time that prospective students come for open days they are sure to see a large number of students walking around wearing funny clothes. If I was thinking about coming to Oxford it would put me off. It is rather sad that Oxford students keep voting to continue this tradition, but perhaps it tells you something about the wisdom of elites.

Which brings me to what I think is the crucial point: why is there this presumption that we should be governed by a meritocratic elite? Ability in a particular subject does not seem to be critical. No one suggests the Chancellor should have an economics degree rather than a 2.1 in modern history. (In the past even numeracy seemed not to be required.) The idea that politicians are having to deploy skills that you can only develop at university is a little naive. Most do not have the time to think very deeply about anything, and when issues that involve any knowledge arise they take advice. This is why I have no problem with the kind of delegation you get with central banks or infrastructure commissions. The main difference in those cases is that the public get to hear about what the advice is.

People in universities talk a lot about non-subject specific skills, like developing critical faculties, but arguably some of the crucial critical faculties for a politician are better learnt by leaving university and doing a job. Good judgement does not come from intellectual ability: Chris Dillow argues there is little correlation between high IQ and career success. Now I’m not going to pretend that, other things being equal, I would be indifferent to whether my MP had an economics degree or an NVQ in catering. But other things are not equal. We have a representative democracy, and one way to make sure it works well is if the people chosen to represent us are to some degree representative of the population as a whole.

Of course compatibility between democracy and meritocracy, and the merits of a meritocracy itself, are big issues. It is telling that the book that coined the term meritocracy, by the great Michael Young, had difficulty finding a publisher and was not reviewed by any scholarly publication. But I suspect what is going on here, at least in some quarters, is far simpler, and is a reflection of Trudeau’s remark. It is 2015, so it is no longer acceptable in public to argue that we should be governed by people from a particular class or background. For people who would still like to make that argument, the next best thing is to talk about which university (if any) a politician has been to.        

Greece: of parents and children, economists and politicians

Not part of the mediamacro myths series, but in a way related.

Chris Giles has a recent FT article where he describes how non-Greek policymakers (lets still call them the Troika) see themselves like parents trying to deal with the “antics” of the problem child, Syriza in Greece. He splits these parents into different types: those that want to act as if the child is grown up (though they believe they are not), those who want to be disciplinarians etc. As a description of how the Troika view themselves, and present themselves to the public, the analogy rings true. It certainly accords with the constant stream of articles in the press predicting an impending crisis because the Greeks ‘refuse to be reasonable’.

In FT Alphaville Peter Doyle writes about a recent meeting at the Brookings Institution in Washington, the highly respected US social science research/policy think tank. In that meeting Wolfgang Schäuble and Yanis Varoufakis, finance ministers of Germany and Greece, gave back-to-back presentations. He describes how “Schäuble was avuncular, self-effacing, and Germanic, and was tolerated rather than warmly embraced by his hosts.” In contrast “when Varoufakis spoke, eyes burning with anger, his hosts were animatedly engaged.” The audience actively sympathised with the position of Greece, and asked “how it felt to be right but penniless”. He writes “There was no doubt where the hosts’ sympathies lay between their two guests.”

I am not surprised at all by this account. The arguments that many of us have made about how far Greece has moved and what agonies it has endured in order to satisfy the unrealistic wishes of their creditors are I think widely shared among our colleagues. We know that if Greece was not part of the Euro, but just another of a long line of countries that have borrowed too much and had to partially default, its remaining creditors would be in a weak position now that Greece has achieved primary surpluses (taxes>government spending). The reason why the Troika is not so weak is that they have additional threats that come from being the issuer of the Greek currency.

It is important to understand what the current negotiations are about. Running a primary surplus means that Greece no longer needs additional borrowing - it just needs to be able to roll over its existing debts. Part of the argument is about how large a primary surplus Greece should run. Common sense would say that further austerity should be avoided so that the economy can fully recover, when it will have much greater resources to be able to pay back loans. Instead the creditors want more austerity to achieve large primary surpluses. Of course the former course of action is better for Greece: which would be better for the creditors is unclear! The negotiations are also about imposing additional structural reforms. Greece has already undertaken many, and is prepared to go further, but the Troika wants yet more.

As Andrew Watt points out, from the perspective of the Eurozone and IMF, this is all extremely small beer. [1] You would think the key players on that side had more important things to do with their time. The material advantages to be gained by the Troika playing tough are minimal from their perspective, but the threats hanging over the Greek economy are damaging - not just to investment, but also to the very primary surpluses that the Troika needs. So why do the Troika insist on continuing with brinkmanship? Can it be that this is really about ensuring that an elected government that challenges the dominant Eurozone political and economic ideology must be forced to fail?

In a recent post that I (jokingly) entitled ‘Should economists rule?’ I suggested that much of the debate about the delegation of economic policy to economic experts was really an issue about political transparency rather than diminished democracy. Elected politicians normally always have ultimate control. Sometimes ‘delegation’ amounts to little more than making the advice they receive transparent: contracting out the fiscal forecast to the OBR would be an example. [2] All that democracy loses in this case is the ability of politicians to conceal or manipulate the advice they receive, and to fool the public as a result. Greece may be (unfortunately) a good example of how far politicians are prepared to go in misleading their own electorates to cover-up their mistakes and achieve their own political ends.

  

[1] The IMF mainly consists of hundreds of economists, but it is run by politicians, and on issues like this the politicians tend to take control.

[2] With central bank independence they do lose control, but normally with the power to take back control in some way. Furthermore, if the undemocratic central bank persistently made bad decisions, taking back control would be popular. An exception is the ECB, which may help explain why many of its words and actions are seriously problematic.

Should economists rule?

Tim Harford in the FT talks to seven random mainstream economists about their radical ideas for economic policy. (Podcast, not pay walled, here.) Nick Stern wants green cities (with much greater economic autonomy), Jonathan Haskel wants more spent on research (because the returns are very high), Gemma Tetlow wants to merge income tax with national insurance, Diane Coyle wants to reduce boardroom pay, John van Reenen wants new institutions to promote infrastructure, Kate Barker wants changes to how housing is taxed, including capital gains on main residences, and Simon Wren-Lewis wants ‘democratic helicopter money’.

You can find more details about democratic helicopter money here. The democratic bit is that the central bank gives the created money to the government on condition that it is used for a stimulus package, but the form of the stimulus package would be the government’s choosing. I was impressed that Tim managed to turn a very pleasant chat over coffee (while taking few notes) into a coherent account of my argument. The only point I might have added is that my suggestion of turning helicopter money democratic is in part to avoid some of the political difficulties he alluded to.

The common strand in many of these suggestions, which Tim draws out, is a desire to replace direct political control by something more technocratic. Now you could say that this is simply a power grab by economists. However if you think about the examples here, they represent important and widely recognised policy mistakes which tend to be universal and persistent: failure to deal with climate change, failure to invest enough in R&D, unnecessary complications in the tax system, runaway boardroom pay, failure to invest in infrastructure even when borrowing is ultra cheap, a broken housing sector and procyclical fiscal policy. It is not as if the status quo is doing just fine.

I would add just two observations. First, the argument is often not about ‘losing democratic control’, but instead about advice being open and transparent. The alternative to some advisory body, whose deliberations should be publicly available and subject to scrutiny, is often secret advice from the civil service, or worse still from policy entrepreneurs. Second, what is thought political infeasible today may relatively quickly become commonly accepted.

I was quite surprised that Tim thought democratic helicopter money was particularly radical and politically infeasible. But then I remembered fiscal councils. My first published piece advocating (advisory) fiscal councils was in 1996, and for more than a decade this was considered the impractical idea of a few ‘out of touch’ economists, who were obviously anti-democratic. Then, little more than a decade later, the idea very quickly became acceptable. Nowadays, it seems like fiscal councils are everywhere. So the one part of Tim’s piece that I would not take too seriously are his scores for political feasibility and radicalism. Today’s supposedly radical idea can quite quickly become received wisdom.

Protecting the public from policy entrepreneurs

One of Paul Krugman’s first books, Peddling Prosperity, made a distinction between academic economists and people he called "policy entrepreneurs". These are individuals who promote particular intellectual positions and ideological policy prescriptions which have little or no academic support, but which may appeal to certain politicians.

I remember it as a great book, and unfortunately one of the main subjects - the idea that tax cuts pay for themselves - is still current in the US. It remains the case that this idea has virtually zero academic support, but for whatever reason - the activities of policy entrepreneurs being one - it still has a tight hold on the Republican Party.

I also remember being dissatisfied with the concept of the policy entrepreneur. It seemed to me that the book failed to situate them in a more general framework of how different interests influenced policy. Why were policy entrepreneurs particularly prevalent in economics? Could academics also be policy entrepreneurs? But that was the social scientist in me speaking. It was clear that such people existed, and that their influence could be far from benign.

I was reminded of all this when someone referred me to Andrew Sentance’s latest piece where he advocates moving to a zero inflation target. Coupled with George Osborne and David Cameron proclaiming zero inflation as a great success, a horrible thought occurred. If these guys were re-elected, might they find the arguments of Andrew Sentance appealing, and actually go for zero inflation? (In the UK, the Chancellor sets the inflation target.) Getting rid of inflation completely - sounds like a vote winner!

Why is it a horrible thought? Because all the academic discussion has been going in the opposite direction, for a very good reason. The Great Recession has highlighted the problems caused by the lower bound for nominal interest rates. That problem will not go away if that lower bound turns out to be -1% rather than zero. The discussion of secular stagnation has highlighted how the ‘underlying’ level of real interest rates has steadily fallen over the last few decades. Put the two together, and you see that a 2% inflation target may mean that we hit the interest rate lower bound far too frequently for comfort. A higher inflation target is one way, although not the only way, of reducing this problem.

Given this, calling for a zero inflation target seems perverse. In response, Andrew Sentance says this: “And the fact that a target of zero inflation may not allow central banks to easily impose negative real interest rates may actually be a good thing – protecting savers, who have suffered heavily as a result of very low interest rates since the financial crisis.” This is just the kind of thing a policy entrepreneur would say: identify your target interest group, and appeal to their interests over the common good. A politician who wants to appeal to savers might think that sounds like a good idea, and before you know it the policy is in place.

I suspect things have moved on a little since Peddling Prosperity was published. The role of think tanks is probably greater. The good ones are a means of channelling academic research, as in this very recent discussion of how to enhance real wage growth from the Resolution Foundation (which I would call excellent if it didn’t have a contribution from me). But they are matched by others that are effectively the institutional equivalent of policy entrepreneurs.

One answer to this problem is delegation. If you delegate an issue to a non-political body, that institution is going to be less swayed by the policy entrepreneur, and more influenced by knowledge and evidence. The independent central bank is an obvious example. It is interesting that one of the contributions to the Resolution Foundation volume, from John Van Reenen, calls for a “permanent infrastructure strategy board”, to improve the level and quality of national infrastructure. Of course with delegation comes the danger of power without accountability, and one particular central bank is a good example of that.  

Is delegation the only way we have of protecting ourselves from the policy entrepreneur? I have one final thought. (The idea comes from Chris Dillow, but he said it on my blog first!). Policy entrepreneurs exist in part because of sectional interests. The problem arises if sectional interests drown out evidence based policy. Society as a whole clearly has an interest in evidence based policy, but one institution that is well placed to protect society’s interest here is academia. Although - in the UK at least - academia encourages the dissemination of research, most academics are always going to value their research above its dissemination, because that is how internal incentives work. So maybe the academic sector needs to create a few policy entrepreneurs of its own, whose mission is to disseminate not their own research, but research in a whole field. One of two examples already exist - maybe we should have more of them.  

 

Wishful thinking and economics

Economics is often called the dismal science, and the Scottish referendum showed why this description has stuck. The Yes side appeared full of hope and optimism about what could happen once the constraints of Westminster rule had been cast off, while the No campaign kept on going on about one problem or other, which usually involved economics.

The general meme is that this negativity was a tactical mistake by the No side, but it was a quite understandable mistake, because the economic problems were large and self evident. It is no surprise that the vast majority of economists thought Scotland would be worse off under independence (see here, or here, or here). They had looked at the numbers and issues, or looked at institutions they respected that had done so, and thought this does not look good. Even for some of those economists who are in favour of independence, like Joe Stiglitz for example, it is clear that the attraction is despite, rather than because, of the basic macro and fiscal numbers. (See also Adam Posen’s response.)

This is of course not new. Politicians on the right like to believe that tax cuts will pay for themselves, and it is boring economists who (mostly) point out this is not true. Politicians of all shades thought that austerity would not have much impact on output and growth, while the vast majority of economists knew better. One of the reasons for deficit bias is that politicians believe that their policies will galvanize the economy and raise the tax base, and most of the time the macroeconomy stubbornly refuses to be impressed.

Now it is tempting to say, given this evidence, that politicians will believe anything that suits them. But what the independence referendum showed us is that voters have similar problems. As the campaign progressed the stronger the Yes vote became, and there is some evidence that this reflected additional information they received. As I suggested here, the problem is that this information was superficially credible sounding stuff from either side, but often with no indication from those who might have known better of the quality of the analysis.

For me this has always been the major argument for establishing fiscal councils - independent institutions who are charged with, at a minimum, scrutinising fiscal projections. Although the OBR (the UK’s fiscal council) has a remit that is quite narrow, we also have the highly respected IFS. In Sweden the fiscal council itself has a much wider economic remit.

Whenever I make this point, someone puts forward the argument that this is anti-democratic, or that I want economists to dictate decisions. This is wrong on at least two levels. First, my general argument is not specific to economics, but involves any area that involves technical expertise. Indeed, the case I make here is partly to avoid politicians using the views of a small minority of economists as cover. Second, the problem with democratic accountability as normally defined is that it is very weak: voters make one decision every five years that involves a whole basket of issues. I would suggest that charging an institution with a small set of tasks, where there is effective democratic oversight over the performance of that institution, can make that institution more accountable to the electorate than any politician doing the same.

In the case of Scottish independence, although we did not have a direct assessment of fiscal prospects from the OBR, that organisation’s oil revenue forecasts were used by the equally respected and independent IFS to point out the problematic outlook that an independent Scotland would face. Although the Yes side attempted to suggest that the OBR was part of the very Westminster elite that it wanted a divorce from, I suspect many voters saw this as independent analysis and were concerned by it. In a world where politicians can always find some experts to back their view, I suspect it is only through singular institutions like the OBR and IFS that the views of the majority of economists get to have some influence, and the economics of wishful thinking gets exposed.

Could aggregate fiscal decisions ever be delegated?

The political battle over delegating decisions over monetary policy to central banks has been fought and won. There may be serious concerns about accountability in some countries, and mandates in others, but there seems to be a political consensus in most places that delegation in this respect is a good thing. (I know some readers disagree with this consensus, but this post is a question about what could happen, rather than what ought to happen.)

There is no major country which delegates decisions over aggregate fiscal policy. I stress aggregate here: I’m not suggesting decisions about particular tax rates or types of spending could be delegated. Instead an independent fiscal institution could set a target level for the budget deficit, and leave it up to the government how that target was achieved. Furthermore the choice between meeting the deficit target using tax changes or spending changes would remain with politicians, so key questions about the size of the state would stay under democratic control.

I’m reminded of this question not by the impending UK autumn statement, but because I have just received my copy of a new collection of essays edited by George Kopits. Its title is “Restoring Public Debt Sustainability: The Role of Independent Fiscal Institutions”. The story behind the book is interesting in itself. Its basis is a conference in Budapest organised by the former Hungarian Fiscal Council. Although a few fiscal councils [1] existed a decade ago, in the last ten years many more have been established, and that included one in Hungary that George chaired. All such councils are advisory - none can tell governments what to do. The meeting in Budapest was I believe the first international gathering of these councils, as well as a few academics that had a particular interest in these institutions. (It is what led me to create this website.)

The conference was a prelude to both success and failure. The failure was that soon after the conference the Hungarian Fiscal Council was effectively abolished by a new government. For that government this act was a good indication of things to come, as others have documented. The brief story of Hungary’s Fiscal Council is told in one of the chapters of this book. However, the success is that, with George’s help, the OECD took on the task of holding regular gatherings of fiscal councils, and it has issued a statement of principles which are an appendix to the book’s introduction.

A few of the essays in the book touch on the question I posed at the beginning of this post, including my own, which compares the delegation of monetary and fiscal policy. In a sense the demise of Hungary’s fiscal council explains why most of the discussion at the conference was happy to see such councils as advisory only. Giving governments advice they may well not want to hear is difficult and dangerous enough, and so fiscal councils need to be well established (and therefore less vulnerable) before we can think of going any further. One step at a time. 

Yet once these councils have been established, it becomes easier to imagine the possibility that delegation could go beyond advice to actual control. Take the UK case for example. The government sets its fiscal mandate (cyclically adjusted current balance in 5 years time), just as it does the inflation target. The OBR then tells the government what it needs to do to meet that mandate. So, having set the mandate, the amount of aggregate discretion left to the government in each budget is limited. It would seem quite a small step to let the OBR decide how quickly the mandate should be achieved. Another small step would be for the government and OBR to negotiate over the mandate itself (just as the central bank and government negotiate over the inflation target in New Zealand).

Small steps, but much too large in political terms right now, as I once discovered when giving evidence to the Treasury Select Committee. (See the second footnote to this post.) Yet in ten or so year’s time, when more of these councils are well established, I can see things might be quite different for two reasons. First, when the recession is finally over there will be a clear consensus that a slow (and state contingent) reduction in net debt levels is required, yet some governments may start to waver from this task for short term political gain. Second, it will have become even clearer that governments, by undertaking austerity at just the wrong time, inflicted substantial damage on their economies, and that maybe everyone would be better off if they were not given that opportunity again.

[1] I use the term fiscal council to cover much the same set that George calls Independent Fiscal Institutions. His term is probably more accurate, but I still prefer fiscal council! 

Delegation and accountability

Ian Mulheirn of the UK's Social Market Foundation uses lots of evocative phrases in a recent post on the OBR’s role in the Autumn statement: he talks about the wizard of OZ, economic high priests handing down prognostications on tablets of stone, Robert Chote (director of the OBR) as a kind of Pope, and more. But behind all this is a crucial point about the delegation of key economic judgements to experts. Ian expresses a feeling that is shared by many, but which I think is mistaken.

First a brief recap. As I explained here, given the Chancellors fiscal mandate, the extent of UK austerity depends crucially on the judgement of the UK’s independent fiscal council about what the output gap is. Now, its the Chancellor’s choice to pursue this path, and as I argue here, it is not a good path in the current circumstances. But having set these parameters, the OBR’s judgement is critical in determining the medium term  fiscal stance. Unfortunately, given the recent behaviour of UK productivity, no one has much of a clue what the current output gap is. Until the Autumn statement the OBR had been following a consistent approach, based on survey evidence, but this time it found that approach produced results it found unbelievable. So it is now, like everyone else, making it up as it goes along.

Ian does not disagree with this move, and as he notes others have gone further than the OBR in discounting the survey evidence. But nevertheless he says of this change: “ The loss of consistency and the sudden wholesale re-evaluation of its approach makes the OBR’s processes opaque and unpredictable for outsiders.” This is true, but would he rather the OBR stuck to an approach to measuring the output gap that it, and most others, no longer believe - just for the sake of consistency?

I think his real complaint is about accountability. To quote again: “Back in 2010, the case for the OBR was that independent economic experts would yield better judgments about crucial things such as the structural deficit than politicians. What that argument overlooked was that politicians are at least accountable for their judgments at the ballot box.” Now I think many feel the same way, so lets explore just what is meant by accountability here.

A political party is accountable at the ballot box for everything it does, all at once. And I can safely say that you will find it very hard to discover a voter who will say in 2015: I’m not voting for the Conservatives because the Chancellor got his calculations about the output gap wrong. By contrast, Robert Chote's reputation will depend in large part on the judgements he makes on this issue. Partly for that reason, I know who I’d prefer making these judgements, even though I cannot vote for or against him.

There is also a certain naivety in the way even some macroeconomists talk about evaluating these judgements. If we are talking about a forecast, they suggest the judgement is simply based on whether the forecast is right or wrong. Yet anyone who knows anything about macro forecasts knows this is silly. To test the ability of a macro forecaster by results, you need a large number of forecasts to separate luck from judgement, by which time the forecaster is safely drawing their pension. The only short term criteria we really have to make a judgement is the quality of their analysis, as judged by other experts.

This is why it is very important that an institution like the OBR or a central bank is accountable in a clear public manner to those with expertise in the area. If that institution starts taking judgements that clearly deviate from what outside experts regard as reasonable, there should be mechanisms by which the leadership of that institution can be changed. The way the Treasury Select Committee works in the UK, while far from perfect, provides accountability along these lines. The absence of similar mechanisms in the Eurozone is a real concern. Where such accountability exists, I think it is superior to any appeal to the ‘judgement of the ballot box’.

As I have argued before, there are structural flaws in getting politicians to make judgements that involve technical expertise, which the ballot box does not resolve. Delegation to independent institutions can avoid these flaws. However these institutions will invariably have to tread a careful path, because their advice has political implications. Here I do have a little sympathy for Ian’s point of view. There is no doubt that the current government has taken every opportunity it can to use the OBR as cover. In his Autumn Statement speech the Chancellor again used analysis the OBR has done about its forecast errors to suggest that the UK’s second recession had nothing to do with austerity. This is a simple case of economic deceit.[1] If my judgement had been misused in this way, I would want to make that misuse as clear as possible in a very public manner, because I had a reputation to protect. Whether the OBR has done that in this case I leave as an exercise for the reader.



[1] Austerity in itself will depress the economy, but a forecast that included it could still be optimistic because of other factors. If these other factors do not materialise, the forecast will be wrong for that reason, but austerity has still depressed the economy. Now whether some of the OBR’s forecast error is due to underestimating the impact of austerity is another matter, so I will not comment on it here, as others have already done so.

A political economy argument for economic policy delegation

In a previous post I talked about an example of the pernicious impact that politics can have on academic economists, and promised to write something on how this might be avoided. (For a more recent example, see here.) Now one response to this is to shrug ones shoulders and say it is inevitable given the nature of the discipline. It would certainly be naive to imagine economics could ever be free of ideological influence.  However I do not think it is unreasonable to try and discourage situations where evidence is distorted, and in particular to try and avoid occasions where minority views are turned into policy because they happen to fit certain political prejudices.

As I have argued before, you cannot rely on the media to do this. Much of the media actually encourages this problem, by giving minority views equal airtime. One of the really depressing developments over the last decade has been how, when the issue of climate change is in the news, the media often tries to ‘balance’ the views of some climate change scientist with someone from the climate change denial community.

In the case of climate change, one way that scientists have tried to overcome this problem is by ‘learned societies’ issuing reports. In the US we have the National Academies, and in the UK the Royal Society. Now it is interesting to wonder whether economics could ever do something similar, but you also have to ask how much that would achieve. As I have noted before, no amount of expert opinion stopped certain newspapers in the UK hyping the imagined link between the MMR vaccination and autism, and many politicians worry more about what is in newspapers than what academic opinion says. Some may even encourage erroneous fears for political ends.

The problem in essence is this: on some issue with a significant technical content (i.e. requiring expertise), there is a clear majority amongst academia on what the answers are, but also some minority opinion suggesting something different. Answers are correlated with political preferences, so politicians pick the answers (and the advisors) that suit those preferences, whether they are in a majority or minority. They face no comeback from the media, who instead encourage the view that there are two, evenly populated, sides. Now of course occasionally the minority view will turn out to be the correct view, but most of the time it will not be. So how do we give more weight to the majority view?

One answer is institutional delegation. The government sets up a permanent body (or enhances an existing body) with the remit to focus on the contentious issue. By establishing the institution itself, it gives it political authority. The institution is designed as far as possible to be politically neutral: indeed its survival to some extent depends on this, because it wants to outlive any particular government. It is designed to be transparent, which should help it to be resistant to lobbying interests (including lobbying by the government). It may contain the expertise on the issue, or it may find that expertise within places like the academic community. Because it is non-partisan it can sort expertise from opinion, and distinguish between majority and minority views.

The obvious example we have in macroeconomics is monetary policy and central banks. In some ways this delegation was quite easy, because the institution already existed, and it had operational control. However in other respects it was more difficult to achieve, because delegation involved giving complete power to the institution to determine policy. Governments just set some general parameters, and sometimes a specific target. Independent central banks are far from perfect, but if you think returning monetary policy to governments would be a step forward, have a look at some of the strange ideas gaining political currency in the US.[1]

By delegation I do not just mean politicians giving up control. Instead the institution can be charged with providing expertise and advice. The macroeconomic example here is the fiscal council. The advice they provide may be quite specific and limited (as is the case with the UK’s OBR with macro forecasts) or more general and wide ranging (as with the CPB in the Netherlands). There is no obligation for the government to follow that advice, but it may bear a significant political cost if it does not do so because the fiscal council has been established by government to provide authoritative advice.

Sometimes a private institution can emerge to fulfil a similar role, such as the Institute for Fiscal Studies in the UK. However, this role can easily be contested, by think tanks that have a clear political agenda. Here competition is a problem. We already have plenty of competition over ideas: the failure is in getting the better ideas adopted as policy. Whether delegation of advice can be effective will depend on the political system in place. In countries where large sections of the media can be bought, there is less cost to ignoring such institutions, as the experience of the CBO in the US shows (although the effectiveness of the CBO could be improved, as I suggested here). However in other countries with a more politically independent media, there is a greater political cost in overriding advice from independent institutions set up by government.

Macroeconomists have a standard argument for delegation in the case of monetary policy, and various reasons why fiscal policy may be subject to a deficit bias which delegation might avoid. What I am suggesting here is a more general argument for delegation (which goes beyond economics) in cases which mix technical expertise with political controversy.

A particular example where such delegation could be useful is fiscal policy and demand stabilisation. This involves not just the austerity versus stimulus debate, but the macroeconomics of how best to achieve debt reduction with as little damage to growth as possible. One argument against delegating decisions or advice in this area is that the academic community is too evenly divided. I would make two observations. First, I find much less division about fiscal stabilisation policy among those that work in this area than among macroeconomists more generally. Second, would there be so many arguing for austerity today if it was not for the politics of the moment? (Recall that the previous US President used countercyclical policy arguments as part of the case for tax cuts.)

I used to think that fiscal stabilisation issues could be delegated to the central bank, because they know all about demand stabilisation. [2] However the obsession in many central banks with budget deficits probably makes this a bad idea (see the Netherlands). It could be a supranational body like the IMF. But at a national level the obvious alternative is a fiscal council. A fiscal council’s main focus is long term debt control, which is an important issue in its own right (which is why I wrote this) and is sufficient justification to set up such a body. But although the focus of their work should be on the long term, in practice they find they have to spend some proportion of their time (often a very large proportion) on shorter term issues. As a result, the possibility of short term fiscal demand stabilisation could fall within their remit. They can be the apolitical institutional filter that can sort out majority from minority opinion within academia.

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[1] In some ways the current debate over fiscal policy reminds me about how monetary policy used to be debated thirty years ago. To which many would say that with monetary policy we know better now, but I think one reason why our understanding has improved is the role central banks play in fostering this knowledge.

[2] The way the proposal would work is that central banks would be allowed to change a select number of fiscal instruments on a temporary basis. The time spans involved, and any limits on the size of changes, would be established by government. When I once argued for this before a committee of UK MPs, to say the idea was not popular among those MPs would be a definite understatement. I did wonder at one stage whether they might ask for the Serjeant-at-Arms to take me to the Tower for undermining Parliament.